Spain Politics September 2017

Tensions in Catalonia have reached a fever pitch in recent weeks as regional authorities forge ahead in their attempt to hold an independence referendum on 1 October. Spanish authorities, who have declared the vote unconstitutional and banned the referendum, are ramping up their attempts to prevent it from taking place, by seizing control of the region’s finances, raiding Catalan government offices in search of election materials and arresting senior officials.

Although the economy has escaped mostly unscathed from the lead-up to the current situation, Spain’s richest region could face severe economic fallout if Spanish and Catalan authorities remain on a collision course just days ahead of the planned referendum. The stakes are also high for Spain, as the region generates 19% of the country’s economic output. The independence of Catalonia would also visibly impact Spain’s fiscal accounts, since the country would lose a substantial proportion of its tax revenues that would be hard to fully offset with cuts in spending.

So far, the political row has failed to unnerve investors and market participants, who expect Spain’s robust institutions to persevere and the referendum to either not take place or fail to yield a substantive result. However, as tensions escalate, the situation could be reversed. On 20 September, the Spanish government imposed controls on the Catalan government’s finances to ensure no public money would be used for the referendum vote; Catalan authorities argue these measures amount to a suspension of the region’s autonomy. Simultaneously, Spanish police carried out raids and arrests. Appetite in Spanish financial markets immediately soured in the aftermath of these events, with both the country’s top stock index and government bonds underperforming.

The long-standing rift over Catalonia’s independence is unlikely to be resolved anytime soon. If anything, Spain’s recent harsh measures against the regional government have deepened the crisis, ruling out short-term solutions. Over the longer term, however—and assuming Catalonia does not manage to somehow secede from Spain—the two parties would need to find a solution combining enhanced fiscal autonomy for Catalonia and increased infrastructure funding from Madrid. Another possible compromise could leave the door open for a debate to reform the Constitution towards a more federalist system, an idea that has been pushed forward by major Spanish and Catalan political parties.

The alternative scenario would be an independent Catalan republic. However, a unilateral secession from Spain would thrust Catalonia into uncharted waters as the European Union could turn its back on the region. Amid the uncertainty, business investment would plunge, private consumption would take a hit and export-oriented companies would face tariffs and additional administrative controls. On top of that, European funding would be suspended and access to financing for the government would prove a daunting challenge, further stoking the problems of a nascent country.

The predominant view among analysts, including our panelists, is that it remains highly unlikely that Catalonia will actually become independent. While market analysts will keep a close eye on developments following the 1 October vote, there is little evidence that suggests lasting consequences to the Spanish economy, which has so far roared through the year.

Author:David Ampudia, Economist

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Largely reflecting faster growth in the services sector, the IHS Markit composite Purchasing Managers’ Index (PMI) rose to 52.6 in August from 51.7 in July, which had marked the lowest print in nearly six years.

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